We're all familiar with Zynga's (ZNGA) post-IPO run up into the low $14 area and its unceremonious recent plummet since to the upper $2s, and now barely resting above $3. Trading 80% off their 52-week high, it's certain that investors are looking to see if there's value left in buying Zynga at these cheap prices. While the stock may seem to be at an appealing discount for buyers at first glance, the company's fundamentals appear to be a house of cards built on a shoddy foundation of virtual cucumbers in games with declining usage, gaudy amenity-laden costly employee benefits, a CEO that has already cashed a pre-crash $192 million in stock and is facing insider trading accusations, and a revolving door of executives leaving the company.
The primary weakness in the Zynga's business model is that, at some point, people are going to stop shelling out real life, hard earned dollars to buy virtual Zynga items which, according to my conversation with Zynga IR, constitute an extraordinarily large portion of their revenue when compared to revenue made through advertising. This revenue has begun to fall off a virtual cliff that is very real for shareholders. A $2.7 billion market cap valuation (based on Q4 weighted-average forecast share count) for a series of dying "-ville" games is absolutely absurd.
For an extremely apt valuation comparison, Zynga arch-nemesis Electronic Arts (EA) has a 30 year history of operating success and over 9,000 employees. Electronic Arts has, in some years, made over half a billion dollars in bottom line net income, and analysts expect them to make over $300 million this fiscal year on over $4 billion in sales with more growth expected next year. Electronic Arts trades at just around a 15 forward analyst expected price-to-earnings ratio. Conversely, Zynga has only a 5 year operating history, less than 3,000 employees whom they're having trouble holding onto, and are suing Electronic Arts blaming them in part for their failure.
Zynga is expected to have a tiny fraction of Electronic Arts' net income and trades with a multiple of over 46 times forward analyst expected price-to-earnings ratio. Normally, companies like Electronic Arts are rewarded with higher multiples for their growth than competitors such as Zynga, yet Zynga is priced a nose-bleeding three times more expensive. This metric alone suggests another 70% selloff could be in the cards for Zynga.
Meanwhile, while Zynga continues to sport a sky-high valuation, and as if the recent press concerning six executives leaving wasn't bad enough, a growing number of low-level disgruntled employees and ex-employees have been filling up the blogosphere to vent their frustration with the current or former employer at a rate that appears in direct proportion the to number of fans dropping off their games. Alexa.com also indicates declining overall web traffic at Zynga.com. Things at Zynga appear to be in a tailspin, with absolutely no signs of stopping.
Could this be that Farmville, Chefville and Cityville are really all just cannibalization-ville? All of these games appeals to generally the same people, audience and players. It's little wonder that as each new game comes out, there also tends to be a large dropoff in the traffic of previous games. Cannibalization occurs in marketing when a company introduces a new product that serves to take away sales from its other products. How many Farmville users who start playing Farmville 2 are really going to also use the original? How many people who quit playing the original Farmville or passed on it in the first place are going to really start up on its sequel?
What's worse is one has to wonder how badly each -ville game "eats" off the others. For a simple comparison, Facebook (FB) indicates 18 million monthly users for Farmville, but only 1 million monthly users for Farmville 2, or 95% less. It's unrealistic for most users to play both games at the same time and even more unrealistic for users to buy virtual items in two games at once. So where is the growth going to come from?
With Apple (AAPL) products, the iPad may cannibalize the Mac a bit, but many people find owning both to be quite useful. It is tough to imagine somebody who spends hours a day already playing Farmville to suddenly add several more hours a day playing Chefville and another several hours a day playing Cityville. How many gamers go from playing Madden '13 back to Madden '12? They don't. The point? Zynga is becoming its own competitor, killing off sales from within.
Glassdoor.com is a website where employees and former employees can rate and review their companies. For Zynga, the ratings and reviews have suddenly turned quite dark, possibly hinting of terrible turmoil brewing at Zynga in recent days and weeks. Consider this: the 89 total ratings have average star rating of 3.1 (which is slightly better than neutral) over the last 2 years, but in the last 2 weeks 50% of the most recent 10 reviews were "dissatisfied" or "very dissatisfied" compared to only 10% of those in the 20 reviews just prior spanning over 2 months. One blogger in particular made a hair-raising note -- "I think [Zynga's] games are [on their deathbed]. Everyone I've spoken to so far within the company says that. I have friends in the mobile platform division that say the platform will be late. The DAU is falling consistently. I can go on and on. Also the ville games aren't monetizing much anymore."
People are citing online gambling as Zynga's potential out for reorganizing the company, with Zynga hiring a new COO with experience in the online gambling industry. People quick to pick up on this and dive into buying shares are missing a couple of significant points. The major point being, that according to Zynga IR, 60% of their total player populous is US-based. Online gambling is currently not legal in the US.
Secondly, people that are going to risk their money online are going to be looking for credible companies that they feel secure with when it comes to paying out and regulating game. Is the company that produced Farmville going to be the same company you're going to trust to govern your high-limit poker game, especially in the wake of the Full Tilt Poker ponzi scheme disaster? It is also worth asking: how much is it going to cost to develop these games, develop the banking infrastructure and secure the proper regulations for online gambling?
It seems more likely that the real online gamble is going to lie in the portfolios of unaware investors that are easily duped into buying Zynga at this or any price.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in ZNGA over the next 72 hours.